Choosing a 529 Plan

A few weeks ago, I put out a call on Twitter and on Facebook for detailed posts that people would like to see. I got enough great responses that I’m going to fill the entire month of July – one post per day – addressing these ideas.

On Facebook, Edita asks a simple question: “Among diffrent 529 plans.. which one to choose?”

First of all, let’s talk about what a 529 plan is. A 529 plan is “a tax-advantaged investment vehicle in the United States designed to encourage saving for the future higher education expenses of a designated beneficiary.” (source) In other words, it’s an account that you put after-tax money into (meaning ordinary money out of your checking account). That account has a stated beneficiary (often your child, but it might be you if you’re saving for your own future graduate education or something to that effect). When money is withdrawn from that account for educational purposes, you do not have to pay taxes on the returns that money earned while sitting in the account.

There are two distinct types of 529 plans: prepaid plans and savings plans. Prepaid plans are less common (only 11 states have them), but they usually mean that you’re directly “pre-paying” for tuition at public universities within that state by buying tuition credits at that school. These credits are based on current tuition rates and thus are a bargain if your child is going to go to that school. Savings plan 529s are much more common. They function much like a savings account, where you deposit money, it grows within that account, and then you can withdraw it to spend on educational purposes.

Finding the right 529 plan is tricky because so many different states offer them and individual states have differing tax rules when it comes to 529 plans. For example, some states have rules where you have to pay taxes if you withdraw money from another state’s 529 plan.

The first step I would take is identifying the “must-have” features. This depends a lot on your situation and each situation is different. For me, there are four “must-have” features.

It must be a “savings”-style 529. I do not want to lock my children into a specific university or small set of universities.

Other family members must be able to make contributions. I want grandparents to be able to easily contribute to their grandchildren’s 529 accounts.

I must be able to transfer account ownership at any time. This ensures that the account will be there for my children no matter what happens in my personal life between now and when they need the account.

I must be able to meet the minimum contribution level. This can certainly be a big concern for some families who have to really stretch to make payments into the 529 account.

There are actually quite a few plans that meet these criteria. So, the first step I would take is to look at my own state’s 529 plan. Using your own state’s 529 plan minimizes the chances that you’ll be docked by having to pay income taxes on the plans in other states (of course, this is a non-issue if you live in a state without state income tax).

For me, the search ended here. I’m a big fan of College Savings Iowa, as it met all of my needs quite well while also offering strong investment choices (they’re backed by Vanguard). Which brings me to my second factor…

If you’re not completely sure about your own state’s 529 plan, start comparing them. This is particularly true if you live in a state without income tax and plan to live there for a while.

The biggest issues you’ll need to look at are the quality of the investments offered in the plan. I would not base this comparison on past performance. Past performance is not an indication of future results – it’s one factor among many. Not only that, many 529 plans have a relatively short history, meaning the past performance data is limited and not particularly valid for comparison.

Other factors that are more important (from my perspective) include the diversity of investments offered within that state’s plan (the more the better), the availability of “targeted” funds that mature when your child graduates from high school, and low fees (such as investment fees, program fees, and other expenses).

Other key factors I would look for in a 529 include easy online access to accounts (most states have this, thankfully; it’s almost a make-or-break feature for me), a good customer service reputation (Google for reports from users), and the ease with which they make rollovers into other 529 plans possible (in case I move or some other change occurs).

There are a lot of tools online that will help you compare the features of 529 plans (like this one), but the big factors in choosing a plan aren’t strictly investment based. They have more to do with you and your child’s future than anything else.

My husband and I just did a 529 search because we have a 5 month old daughter and wanted to get saving as early as possible. We used savingforcollege dot com to help compare plans, and I found it very helpful. We ended up choosing Utah’s plan, not our home state of Pennsylvania’s plan. Luckily Pennsylvania gives you the tax break no matter what 529 you choose.

Very timely article for me… I’m planning on starting some educational savings for my younger siblings. I’m not sure a 529 is right for my needs (the oldest is about 3 years from starting, the youngest 5 years, which is a bit short of a time frame for the risk), but it’s an option I’m exploring. I know some plans can have multiple beneficiaries (i.e. one plan, for all your children), which is a plus. I also am curious what qualifies as an “educational expense” (tuition only? books?) . I’m planning a thorough internet search later this week, but I’d love to hear other reader’s experience with these plans, especially from people who have actually used the funds already (i.e. have older children in or out of college). Thoughts?

I now live in Indiana (started in PA when we started our 529s) and I love that there’s a state tax break on our contributions. You get a 20% tax CREDIT which is awesome! So, contribute $500, get $100 back on your state taxes.

I never paid much attention to which state sponsored the 529 plan, and, living in Texas, state income taxes aren’t a concern. We’ve invested heavily in the (I think) New Hampshire plan run by Fidelity. The key selling point for us was the MasterCard we got from Fidelity, which rebates 2% of each year’s purchases, up to $1,500, into the account. I recently found that Fidelity also has an AmEx card that rebates 2%. The credit cards are especially great if you travel a lot on business and can charge your expenses to a personal card, or if you own your own business. Over the last 10 years, the rebates have totaled more than $10,000.

We also have another 529 through Upromise, which enables us to get online shopping rebates deposited into the account, and which has a BofA MasterCard that rebates 1%, with no annual maximum.

There is an independent prepaid 529 plan for private schools which offers tuition and fees to 270 different schools across the country. However, something Trent didn’t mention was with the prepaid tuition plans, not only are they rare, they’re becoming more scarce, and you may not actually receive the full value of the credits you bought. I believe this is going on in Alabama right now, where the state doesn’t have the money to honor the prepaid 529 plans.

Curious, what state penalizes you for using another state’s 529 plan? I couldn’t find any information on that.

USAA has a consistently highly ranked 529, if you’re eligible to bank there.

Texas had a prepaid tuition plan several years ago. It was terminated a few years back. It’s now facing a shortfall.

Sometime after the first one was terminated, a second one was created. Its terms are rather complicated, but, in essence, if I understand it correctly, it shifts the funding burden from the state to the university. An account owner purchases credits for tuition and fees for a set number of hours at specified rates that may be adjusted annually. The credits may be presented to any state institution, which is obligated to honor the number of hours purchased.

It appears that, if there is a shortfall, the university must make up for it. And, with state funding on the block every biennium, the logical place to make up that money is in tuition and fees fort students who aren’t participating in the plan — suggesting that non-participating students will face increases even higher than they would have if the state did not have such a plan.

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